QE gets green light but Draghi must proceed with caution

Mario Draghi can ‘do what it takes’ to save the eurozone, but must proceed with care while doing so.

This, in a nutshell, is the decision released week by the advocate general at the Court of Justice of the European Union, Pedro Cruz Villalon.

Mr Villalon was asked to deliver a legal opinion on foot of a reference to the Court from Germany’s Federal Constitutional Court.

The reference came as a result of complaints brought by a group of eurosceptical German politicians, jurists and economists who argued that measures taken by the European Central Bank at the height of the eurozone crisis, in mid-2012, and the German government’s failure to halt these measures, amounted to an infringement of their fundamental rights.

Interestingly, these sceptics were backed up by Germany’s hard left Die Linke party which sought an annulment of the ECB measures known as ‘OMTs’ by Germany’s parliament, the Bundestag.

At the time, the yields on the bonds of peripheral countries including Ireland had soared, leaving the currency zone at risk of collapse.

Mr Draghi, recently- appointed as ECB head, had calmed the markets by vowing to ‘do what it takes’ to save the currency union and shortly afterwards, on September 6, 2012, the bank unveiled plans to engage in what are termed, ‘outright monetary transactions’, under which the ECB would buy up the debt of member state governments in a move designed to restore stability.

The plan may have been unveiled, but it has never been implemented, or even detailed. Mr Draghi’s vow was enough to calm the markets. Yields on peripheral states have fallen dramatically, with the exception of Greece.

Yields on Irish 10-year government bonds have fallen to just over 1%, dropping last week despite ongoing uncertainty over Greece’s continued membership of the eurozone.

A decision of this nature from the advocate general hardly comes as a huge surprise. Nevertheless, it does remove an important element of uncertainty ahead of the Greek elections due in a week or so.

Mr Villalon’s job is to propose and it will be up to the full court to pronounce its final decision, in a few months’ time. The full court nearly always follows the ruling of the advocate general, however.

In effect, Mr Draghi and his officials have been given the go ahead to act, provided that they do so wisely.

The ECB had argued at the court that while the OMT programme is an “unconventional instrument”, it falls within its mandate, its indirect aim being to ensure that the bank can make effective use of the monetary policy instruments available to it.

German opponents maintain that the true purpose of OMT is the transformation, by the back door, of the ECB into a ‘lender of last resort’.

The big German fear is that they will end up picking up the tab for financial commitments entered into by the European Central Bank.

However, the reference by the Federal Constitutional Court has been interpeted in German legal circles as a the throwing down of the gauntlet to the Court of Justice by Germany’s top legal body.

Mattias Kumm, a professor of law at Berlin University and NYU, has accused Germany’s constitutional court of engaged in a dangerous ‘game of chicken’ in which two drivers head towards each other on a collision course.”

The FCC has gone as far as to suggest its constitutional identity, protected by Germany’s Basic Law, is at stake

According to Prof Kumm, however, “its arguments for engaging in ‘ultra vires reviews of European Union acts are ill conceived.”

The advocate general makes it clear, in his opinion, that the ECB must have a broad discretion when framing the EU’s monetary policy.

In what looks like a slap down to the Germans, he suggested that “the courts must exercise a considerable degree of caution when reviewing the European Central Bank’s activity, since they lack the expertise and experience which the ECB has in this area.”

Put simply, the advocate general does not want to put Mr Draghi in the position where he is being sent out to play with a broken bat in his hands. However, Mr Villalon does throw some things by way of comfort to the critics.

The OMT programme will, he says, have to comply with the prohibition on the monetary financing of member states. “It must refrain from any direct involvement in the financial assistance programme to the state concerned” and it “must give a proper account of the reasons for adopting an unconventional measure such as OMT, identifying clearly the extraordinary circumstances that justify it.”

It will have to go well beyond the press release of September 6, 2012, in doing so.

The prohibition on monetary financing of member states is a ‘ fundamental rule’ and any exceptions to it, “must be interpreted restrictively.”

What all of this means is that the ECB has the green light to press ahead with a bond buying programme as part of its effort to combat deflation in the eurozone by means of quantitative easing, but it will have to do so without exposing member state governments to financial losses in the process.

The central bank governors are set to give the go-ahead to QE on Thursday.

Mr Draghi will have a bat which he can swing, but he and his colleagues will have to do so with care rather than with swagger and gay abandon.

The go-ahead for quantitative easing by the advocate general is a boost for the ECB, but the road ahead will not be smooth, writes Kyran Fitzgerald

The big German fear is they will end up picking up the tab for the financial commitments